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The Houses on Happy Lane
Dear Reader,
In yesterday’s missive, I left off scratching my head about the latest housing data. Reaching out for one of my lifelines, our own Bud Conrad, I received the following in reply.
Housing Looks Only a Little Better
By Bud Conrad
The July new home sales were reported yesterday with some positive comments. The raw data in the charts below show only very small improvements.
With very few new homes being built, the inventory of homes for sale is back to more normal levels.
Prices even ticked up just a bit from the Case-Shiller indexes.
The less bad news was helped along by the steep drop in interest rates to 50-year lows. And the corresponding drop in mortgage rates, due to the Federal Reserve’s massive buying of $1.25 trillion worth of mortgage-backed securities and $200 billion in agency debt. Then there are Treasury subsidies and guarantees for Fannie and Freddie to the tune of $280 billion.
An $8,000 tax credit for new home buyers may seem small against the $150,000 average house price, but it is a noticeable part of 20% down on a $100,000 home. It is my opinion that the “green shoots” here are more from the government-applied bailouts and support, rather than from a big turn in the general economy.
Looking forward, there are still new resets of option ARM mortgages, among others, that will raise rates for many holders, who may have to walk away from their homes.
I am not saying real estate won’t ever recover. In fact, once inflation returns, historically housing can offer a good way to protect yourself from price escalation and dollar destruction. But it seems too early to call this little improvement a turn in the economy.
David again.
In addition to the fact that builders have pulled in their horns, helping to reduce supply, there are other factors at play here – including a number of property owners who have converted a “for sale” property into a rental.
And there’s something else – the reluctance of lenders to take physical possession of homes that are either in foreclosure or should be, given the borrowers’ failure to make payments. On that topic, an article out of the American Banker yesterday is particularly eye opening. Some excerpts..
Postponing the Day of Reckoning
By Kate Berry, American Banker
August 26, 2009
Pick up just about any city's newspaper or turn on any news show, and if the topic is real estate, the banking industry is likely being lambasted for foreclosing on troubled homeowners.
But industry data and anecdotal evidence suggest banks and servicers have been dragging out the process – not rushing to kick people out of their homes.
Granted, the deferrals may not be motivated by compassion, or even political pressure. Rather, banks and mortgage investors want to avoid repossessing hundreds of thousands of homes, which would produce losses and hits to capital.
"The goal is to hold off on foreclosures and take losses as slowly as possible to keep balance sheets up," said Deborah Voelz, the chief financial officer of National Asset Direct Inc., a New York buyer and servicer of distressed loans. "Everyone is looking at what the ultimate loss is going to be and whether it makes sense to hold off another year or two and mitigate the results."
The foreclosure process -- and it is a process -- now takes, on average, 18 months to two years, up from 15 months a year ago, according to Amherst Securities Group LP. Backlogs in county courts and at servicing companies, along with local government moratoriums, have contributed to the delays. But plenty of signs indicate that the mortgage companies themselves are in no hurry to seize their collateral.
Rick Sharga, a senior vice president at RealtyTrac Inc., an Irvine, Calif., company that monitors foreclosure filings, said banks often start proceedings but then decide "they don't want the property" and suspend the process indefinitely.
Of the 2.3 million homes that received foreclosure notices last year, one-third had been repossessed by yearend, according to RealtyTrac.
Banks also "are allowing borrowers to be delinquent for longer and longer periods of time before initiating foreclosures," Sharga said.
Tom Booker, a senior vice president in the default information unit at First American Corp. in Santa Ana, Calif., concurred. "There are borrowers who are six or eight months in default; they may have exhausted their workout options; but they're put on a forbearance plan because it's an interim to a final resolution, which is foreclosure," he said. "Banks don't want to take the losses now."
… How banks account for delinquent mortgages is the subject of ongoing debate among regulators, bankers and auditors.
Darrell Duffie, a finance professor at Stanford University's Graduate School of Business, said accounting rules give banks plenty of leeway to determine when to take losses.
"Banks are believed to be carrying a lot of loans at accounting levels well above their true market value," he said. "But once a property goes into foreclosure, their options have disappeared."
Timothy Ward, the deputy director of the Office of Thrift Supervision, went so far as to send a letter to chief executives in May reminding them that banks must account for losses when a loan is 180 days or more past due.
Charging off loans "only at foreclosure or when deemed uncollectible" is considered "weak" and not in accord with generally accepted accounting principles, Ward reminded bankers.
"This is the challenge the big banks have," said Fred Cannon, the co-director of research and chief equity strategist at KBW Inc.'s Keefe, Bruyette & Woods Inc. in New York. "They're supposed to take the loss at 180 days, but the initial chargeoffs aren't that much and then we're seeing big REO losses" (when a loan has been reclassified as "real estate owned").
Robert Simpson, the founder and president of Investors Mortgage Asset Recovery Co. LLC, an audit and fraud analysis firm in Irvine, said bankers have little incentive to realize probable losses until forced to do so.
"No one is encouraging banks to quickly book $75 million in losses and then take the heat for it, since they wouldn't have a job for very long," he said.
Standard & Poor's Corp. said Tuesday that its S&P/Case-Shiller index of national home prices rose 2.9% in the second quarter from the first. It was the first sequential rise in the index in three years. Compared to a year earlier, the gauge dropped 14.9% — a slower year-over-year decline than in the first quarter.
But in a note to clients, economists at Morgan Stanley wrote, "we do not believe that prices are actually improving for any part of the housing market, except possibly certain foreclosure markets due to a shortage of foreclosed inventory from the recent drop-off in liquidations. … This drop-off has nothing to do with fewer people becoming delinquent. … Instead, it has to do with banks and servicers reducing the rate at which they take back the properties."
Data released last week by the Mortgage Bankers Association showed delinquent loans growing at a brisk pace. In the second quarter, roughly 4.2 million borrowers were 90 days or more delinquent on their mortgages (a delinquency rate of 9.24%, up from 6.41% a year earlier), the trade group said. By contrast, foreclosures were initiated on just 612,000 homes (a foreclosure start rate of 1.36%, up from 1.08% a year earlier).
… Though deferring foreclosures may help bridge a period of depressed revenues, losses still must be tallied eventually, said Cannon of Keefe Bruyette.
"One of the oldest lines in banking is 'the first loss is the best loss,'" he said. "That's what most lenders believe, but the question is, are they abiding by their own rule?"
Bill Garland, a senior vice president at Fiserv Home Retention Solutions, a unit of Fiserv Inc. in Brookfield, Wis., said many large banks have cut back on loan-loss reserves because they now see a rebound in housing prices, a move he called possibly shortsighted. "People want to believe we're at the bottom, even though there's still a lot of REO inventory coming our way," he said.
You can read the full article here.
bankinvestmentconsultant.com
The piper is yet to be paid in full for the excesses of the recent past, and putting it off won’t make the problems go away.
Motivated Sellers
The impact of the large overhang of distressed properties on the prices of nearby houses is another feature of the current market that needs to be taken into account. According to research by RadarLogic, in many of the most troubled markets – for instance Los Angeles, Phoenix, and Las Vegas – the mean sales prices of the majority of “non-motivated” sellers have now fallen to within one standard deviation of those of “motivated” sellers. A motivated seller is defined as a bank selling off a foreclosed house.
The chart here shows the correlation between the prices of foreclosed homes and those not yet foreclosed, in this case in San Francisco.
This gives rise to a few potentially useful observations.
First, as indicated in the chart just above, it is the most troubled sector of the market that is driving prices in many areas. Why pay more for a house at 123 Happy Lane when you can buy much the same abode located next door at 124 Happy Lane at a steep discount from the bank?
Secondly, because the reduced transaction price of 124 Happy Lane may be the only transaction in the neighborhood for some months, when it comes time to secure an appraisal on your home next door, the comparable will likely come in far below where you as a potential seller would like it to be. Of course, these days no banks will lend above the appraised value – so a prospective buyer, should you be able to wrestle one to the ground at your asking price, would find themselves required to pony up a larger down payment than they are prepared to do. In many cases, that’s a deal killer.
Third, as the values of homes are dragged down by distressed neighbors, an increasing number of homeowners find themselves upside down on their mortgages. Faced with a job loss or other bad news on the personal financial front, the idea of continuing to pay up on a losing asset becomes less and less attractive, perpetuating the downward cycle. Even if people feel that paying is the right thing to do, the hard facts of our beggared society make that increasingly difficult for many.
(A recent poll by Monster.com revealed that 34% of workers have one week or less of savings. Read more here.)
globaleconomicanalysis.blogspot.com
Finally, because prices are being set at the negative margin in so many areas, at some point true value reemerges. Sure, your neighbor may have taken the chicken run or is living payment-free courtesy of the bank, but at some price real estate, unlike certain derivatives, reaches the point of offering a true value. Once that equilibrium point is ultimately reached, prices should bounce off the bottom. But how high?
Back before launching The Casey Report, we presented our macroeconomic data in Casey’s International Speculator (which now largely focuses on the hottest corner of the natural resource market; details here.) In the lead article of the December 2006 edition of that publication, titled “The User’s Guide to Fiscal Calamity” – one of many that warned of the imminent crisis – Bud Conrad presented the following chart.
As you can see, the only U.S. real estate bubble to compare with the one leading into the current crisis was the whopper that materialized just ahead of the Great Depression.
I’m bringing this up to try and answer the question, “But how high?”
As you can also see, had you purchased real estate at the pre-depression top, then in constant dollar terms, the property may have never returned to its prior lofty valuation. And even if you had bought after the market was knocked down by half, you still might not have recouped your value for twenty years or more.
The chart below here, from the Census Bureau, shows the pattern of new home sales over the period of the recently departed bubble. Note that the big run-up in sales this time around came between mid-2001 and mid-2005, though sales volumes remained above historical norms well into 2007. Which is to say, a lot of people were buying into the fiction that house values were a one-way street up -- at the worst possible time. They are now all underwater on their mortgages, though many are still holding on and hoping for a decisive turnaround that will make them whole again on their McMansions. These are false hopes, and as they are ultimately dashed – as they must be if we are ever going to see real estate in a sustained recovery (albeit from a lower level) – the inventory of houses for sale will again rise, and prices will drop.
Simply, despite yesterday’s cheery news on real estate, we are a long ways from being out of the woods. But, that said, one must also add an important caveat: there is no such thing as a “national” real estate market – it’s all local. There are going to be geographical pockets where a solid bottom will soon be put in, or may even already have been. And there will be some terrific bargains for smart shoppers armed with cash to lay on the table in front of anxious sellers.
Speaking of having cash, as early as 2004 we were stressing investors should dump real estate and buy gold. I came across the following chart, from InvestmentTools.com, that shows the result had you followed that advice. The chart displays how many ounces of gold it takes to buy the average U.S. house. What it means is that if you had sold your real estate and switched into gold, your gold would now buy one hell of a house, vs. the result if you had hung on to your house.
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